The Fed concludes its two day meeting Wednesday, June 19, with much anticipation. All eyes are on the Fed chairman and whether he will give more insight in to the possible reduction of quantitative easing, now popularly referred to as "tapering". The financial community and the broader community can thank the media for yet another catch phrase to banter about, not unlike formal popular phrases such as "irrational exuberance", "fiscal cliff", "new normal", and acronyms like "BRICs", "PIGS", and "ZIRP". Although these catch phrases typically go by the wayside after their usefulness runs its course and the media gets exhausted, taper may actually hang around a bit longer than the others. Although there are no real expectations that the Fed will announce a beginning to tapering of the existing QE policy at this meeting, there are growing concerns that inevitably the Fed will have to taper at some point in the future. There are heightened concerns that as a result of the impending end of Ben Bernanke's tenure there will be a "handing off" of sorts of the current policy to Bernanke's successor with at least some indication that an exit is being considered by the current Fed members. This concern is reflected in the bond market through rising rates and in the equity markets through increased volatility.
The impact on the bond and equity markets from the Feds statement may be muted. Bond yields have risen substantially the past 6 weeks and equity markets have seen increased volatility, while rising back to the former highs of the recent past. Although economic data such as labor market and real estate market data have shown relative improvement, the metrics set by the Fed which will drive the decision making policy have not been met. Unemployment still rests higher than the Feds target and inflation has not come close to the Feds desired target. With regards to inflation, if there is any real concern it's that it may be too low. There is increasing evidence that deflation may become a bigger concern than previously thought. Few anticipated that the result of Fed money printing (QE) would be falling prices, but inflation metrics such as PPI and CPI are reflecting weaker prices not stronger prices. This would be a dangerous development as deflation destroys what makes credit markets and the US economic system work. In a nutshell, increasing prices make borrowing and using leverage economically viable by effectively lowering its cost. Deflation eliminates or at least mitigates this process. As such, it seems unlikely the Feds hand will be forced to announce any concrete plans to begin tapering and the markets reaction to the statement should be muted.
The markets expectations of the Fed are another matter. The Fed is not entirely in control of market behavior or market sentiment, for that matter. Regardless of the Feds statement, the market may decide that it will move on without the Fed and price assets without considering Fed comment and guidance. The market will ultimately decide whether it trusts the Fed. The market is seeking clarity from the Fed after many Fed members have made both dovish and hawkish statements about Fed policy going forward. This market uncertainty causes the rise in rates and the volatility seen in the equity market. It will be the Feds job to soothe markets by clarifying its position on current policy and its future course. The Fed chairman has been doing this for nearly eight years now and is quite adept at it. Ben Bernanke will try not to add additional uncertainty to the market and will seek to allay any fears the market has regarding current policy and the transition from his leadership to his successors leadership.
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